State Efforts to Define “Cloud Computing” Spell Opportunity for Taxpayers

A recent Massachusetts letter ruling refines its definition of cloud computing, a rapidly evolving computer medium that includes, among other things, the Internet provision of Software As a Service (SAaS), Infrastructure As a Service (IAaS), and Platforms As a Service (PAaS). SAaS - the most common form of cloud computing – involves the provision of access to software applications hosted on the server of the application service provider.

Many states have yet to provide sales tax guidance regarding the taxability of these services. In years past, states defined the sale of application software in a box off the shelf as a sale of tangible personal property and taxed it accordingly. Then, the Internet and evolving technology enabled software purchasers to electronically download application software from a retailer’s server to their own computers, requiring states to choose whether to expand their definition of taxable software sales to include electronic downloads. However, electronic downloads did create disparity in the tax treatment of such sales versus traditional “software in a box” sales. Cloud computing enables a customer to remotely access an application software provider’s server over the Internet and use the software without downloading it to their own computer.

Many states are lagging behind in their efforts to define and regulate the taxation the rapidly evolving world of cloud computing, leaving this area of sales taxation to be a bit of the “Wild West” in terms of clarity.

In Massachusetts, charges for prewritten software, whether it is electronically downloaded to the customer or accessed by the customer on the seller's server (including the “Software as a Service” business model) are generally taxable. However, pursuant to the Department’s ruling in Letter Ruling 12-8, while the Taxpayer provided access to operating system software in providing clouding computing resources, the Department noted that there was no contractual sub-licensing of software from Company to its customers and no separately-stated charge for the software. The Department concluded that the object of the transaction remains the access to Company's computing resources and storage capacity; the inclusion of the operating system software is incidental as the operating system software merely facilitates the customer's use of seller's computing resources and storage capacity. [Letter Ruling 12-8, Massachusetts Department of Revenue, (Nov. 8, 2013)] As such, where nontaxable computer services are bundled with taxable software that is incidental to the provision of the nontaxable computer services, Massachusetts concludes that the entire charge is nontaxable.

State guidance - or lack thereof - regarding the taxation of cloud computing demonstrates the need for taxpayers to evaluate the manner in which they provide computer resources to their customers, and whether these modes of delivery are now taxable, or should be excluded from taxation.

Many states are lagging behind in their efforts to define and regulate the taxation the rapidly evolving world of cloud computing, leaving this area of sales taxation to be a bit of the “Wild West” in terms of clarity (e.g., Maryland has not provided guidance on the taxability of SaaS, IAaS, or PAaS, but tax does not apply to software delivered electronically or to data processing services). State efforts, such as Massachusetts’, to define and refine the definition of cloud computing demonstrate state efforts to remain on the forefront of evolving tax policy. These efforts – and the lack of guidance in other states - also demonstrate the need for taxpayers to evaluate the manner in which they provide computer hardware and software resources to their customers, and whether these modes of delivery are now taxable in a state, or as the Massachusetts ruling points out, should be excluded from taxation.